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Global Corporate and Investment Banking: an Agenda for Change

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Global Corporate and Investment Banking: an Agenda for Change Global Corporate & Investment Banking Practice Global Corporate and Investment Banking: An Agenda for Change Global Corporate and Investment Banking: An Agenda for Change Foreword 1 Day of Reckoning? New Regulation and Its Impact 3 On Capital Markets Businesses Europe: Beyond the Crisis, New Challenges 31 And Opportunities Asia: The Future of Corporate and 37 Investment Banking Out of the Shadows: Central Clearing of 56 Repurchase Agreements Winning in Flow: Scale Is Everything 83 Foreword 1 Foreword our years after the financial crisis, the agenda for change within the F global corporate and investment banking (CIB) industry remains signifi- cant. In this compendium, we bring together five articles published over the past year that serve as a ready reckoner for the CIB agenda—not just for capital markets and banking, but also for critical components of the bank- ing infrastructure that supports funding. Day of Reckoning explores the impact of new regulation on capital markets businesses. After-tax return on equity for these businesses is likely to fall from 20 percent pre-regulation to 7 percent, absent any mitigating actions by banks. We suggest strategies that banks can pursue to manage the impact of regulation on their capital markets businesses and to maintain an accept- able level of profitability. We examine portfolio optimization, model and data quality improvements, financial efficiency and operational enhancements. In Europe: Beyond the Crisis, New Challenges and Opportunities, we review the impact of new regulation on corporate banking businesses. De- spite significant reductions in credit costs, profits remain well below 2007 peaks in these businesses. Many of the mitigation strategies for capital markets businesses are relevant to restoring profitability to corporate bank- ing. In addition, banks should consider upgrading cross-selling, taking pric- ing to the next level and improving risk culture. Asia: The Future of Corporate and Investment Banking provides a compre- hensive overview of one of the key CIB growth markets. Asia is expected to account for a startling 43 percent of global CIB market growth between 2010 and 2015. Here, the agenda is focused on how to take advantage of three large business opportunities for banks: the rapidly growing mid- corporate segment, the growth of Asia’s capital markets and the continued expansion of regional transaction banking. 2 Foreword In Out of the Shadows: Central Clearing of Repurchase Agreements, we examine an important initiative that would strengthen the bank funding infrastructure. The U.S. repo market is estimated to be $12 trillion, equal in size to the total assets of the regulated banking sector. Here we lay out an agenda that would deliver clear benefits for all participants without being disruptive to the industry: • Novation of bilateral transactions to reduce risk. • Electronic communications networks (ECNs) to match cash supply and demand. • Expansion and substitution of collateral to increase flexibility. Lastly, Winning in Flow: Scale Is Everything highlights findings from the McKinsey Global Capital Markets Survey (focused on revenues) and the McKinsey Capital Markets Trade Processing Survey (focused on trade costs). These surveys provide clear evidence of the major increases in revenue and cost productivity that occur as scale increases. Both small and large players need to pursue agendas that will achieve actual or virtual scale, deliver or access required operations and electronic systems, and make the required organizational changes or tough strategic choices. The agenda for change in the CIB industry is long, and the implementation challenges are many. We hope that this compendium provides helpful insights and stimulates valuable discussions, as banks adapt to a radically altered environment. As always, we welcome your comments and look forward to hearing your thoughts on these critical issues. Dominic Casserley Global Leader Corporate & Investment Banking Practice Day of Reckoning? New Regulation and Its Impact on Capital Markets Businesses 3 Day of Reckoning? New Regulation and Its Impact on Capital Markets Businesses Daniele Chiarella he financial crisis of 2008–2009 prompted a wave of banking reform. Mas- Philipp Härle T sive new regulation has been agreed on in Europe and the United States, and regulators and bankers are now rolling up their sleeves to prepare for the next phase Max Neukirchen of compliance and implementation. Banking leaders are keen to understand the Thomas complexities of proposed reforms and their impact on different businesses. They are Poppensieker especially interested in knowing the effects on those businesses that are the subject Anke Raufuss of the stiffest reforms. This article deals with these questions in relation to the capital markets business. McKinsey studied trading and services in foreign exchange, rates, credit and com- modities, also known as fixed income, currencies and commodities (FICC); cash eq- Originally published in September 2011 4 Day of Reckoning? New Regulation and Its Impact on Capital Markets Businesses Exhibit 1 Capital markets businesses analyzed Business Products and services Foreign exchange (FX) Spot FX, forward FX, FX swaps, FX options, exotic FX derivatives, e.g., digitals, barriers, baskets, knock-ins, knock-outs Flow rates Short-term interest rate and money market, benchmark bonds, covered bonds, ow derivatives Structured rates Structured interest-rate swaps, correlation swaps, ow-ination swaps, long-dated and structured FX, interest-rate hybrids Flow credit Corporate bonds, credit-default swaps, total-return swaps, credit-linked notes, corporate-bond futures and options, asset-backed securities, corporate and residential mortgage-backed securities, par loans, syndicated loans Structured credit Cash-collateralized debt obligations, synthetic collaterized debt obligations, baskets, tranche options, index tranches, correlation transactions Commodities Trading of ow commodities derivatives and swaps of structured products, trading of structured commodities derivatives, structuring of complex hedges, commodities origination, complex investment products, asset-backed trading Cash equities Full-service brokerage/secondary trading of single stocks, direct market access, portfolio trading Flow equity derivatives Delta 1 swaps, Delta 1 certi cates, warrants Structured equity derivatives Structured swaps/options, certi cates, hybrid derivatives, convertibles Prime services Security lending, security nancing Proprietary trading Trading on institution’s account rather than client business Source: McKinsey Global Capital Markets Survey uities and equity derivatives; prime services; and proprietary trading (Exhibit 1).1 The data set is the capital markets businesses of the world’s 13 largest investment banks and investment banking divisions of universal banks, as measured by revenue.2 The regulations considered include Basel II.5, Basel III, the Dodd-Frank Act, and other regional regulations. McKinsey measures impact in terms of post-tax return on equity (ROE). The analysis builds on earlier McKinsey research, namely assess- ments of the broad impact of Basel III and Dodd-Frank,3 and McKinsey’s annual 1 Rates, credit and equity derivatives are further broken down into flow and structured businesses. Investment banking advisory services and primary businesses, such as equity capital markets and debt capital markets, are not within the scope of this article, as they represent only 20 percent of the broader capital markets and investment banking (CMIB) business, are not capital intensive, and are much less affected by regulatory reform. Similarly, corporate banking businesses, such as specialized finance, lending and transaction banking are not in scope. 2 Bank of America/Merrill Lynch, Barclays Capital, BNP Paribas, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan Chase, Morgan Stanley, RBS, Société Générale, and UBS. 3 McKinsey Working Papers on Risk, No. 26: “Basel III and European banking: Its impact, how banks might respond, and the challenges of implementation,” November 2010; McKinsey Working Papers on Risk, No. 25: “Assessing and addressing the implications of new financial regulations for the U.S. banking industry,” March 2011, www.McKinsey.com. Day of Reckoning? New Regulation and Its Impact on Capital Markets Businesses 5 Global Capital Markets Survey and Global Banking Pools.4 It also draws on the experience gained from several projects designed to implement the changes required by Basel III and Dodd-Frank at top investment banks and some next-tier banks, and on insights obtained from participating in industry discussions and regulatory debates. The assessment measures the full impact of regulation, including new capital, liquidity and funding requirements; product-specific restrictions; and structural changes to markets, for example, in securitizations, over-the-counter (OTC) deriva- tives, and proprietary trading. Several of the new rules will be phased in over time through 2019, but for the sake of simplicity their impact is calculated as if they went into immediate effect. The model includes those requirements that have material and broadly similar im- pact on capital markets businesses’ profitability in all parts of the world. Excluded from the quantitative analysis is the impact of new rules that will have widely differ- ent effects on banks (such as capital deductions, whose impact depends heavily on the composition of the balance sheet, and changes to
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